Annex 1. Actions of Select Central Banks to Support Markets during March 2020 Turmoil
Selected Central Bank Facilities to Support Funding Markets
Selected Central Bank Facilities to Support Funding Markets
| Money Markets and Government Securities | Corporate Bond Market | Other Markets | |
|---|---|---|---|
| Bank of Canada | Government of Canada Bond Purchase Program Purchases of Government of Canada bonds in the secondary market to support market functioning and provide monetary stimulus. Bankers’ Acceptance Purchase Facility Purchases of eligible bankers’ acceptances to maintain credit to small- and medium-sized businesses. Provincial Money Market Purchase Program Purchases of provincial money market securities in the primary market. Provincial Bond Purchase Program Purchases of provincial bonds in the secondary market to support the liquidity and efficiency of these markets. Commercial Paper Purchase Program Purchases of eligible commercial paper in the primary and secondary markets to maintain the smooth flow of credit to corporations. |
Corporate Bond Purchase Program Purchases of corporate bonds in the secondary market to support liquidity and market functioning. |
Canada Mortgage Bond Purchase Program Purchases of CMBs in the secondary market to support market functioning and the ability of financial institutions to finance mortgage lending to Canadian homeowners. |
| Bank of England | Asset Purchase Facility A £200 billion increase in the central bank’s holdings of UK government bonds and sterling nonfinancial investment-grade corporate bonds to a total of £645 billion. COVID Corporate Financing Facility For 12 months the central bank and Treasury will purchase commercial paper of maturities up to one year issued by companies making a material contribution to the UK economy. |
||
| Bank of Japan | Measures to Facilitate Corporate Financing Increased the upper limit of holdings of corporate bonds and commercial paper and introduced special funds-supplying operations to facilitate corporate financing. Active purchase of Japanese Government Bonds (JGBs) Conducted additional outright purchases of JGBs. Additional measures to maintain stability of the repo market Relaxed the conditions of its Securities Lending Facility (SLF). Conducted sales of Japanese Government Securities (JGS) with repurchase agreements intended to provide the market with JGS. |
Purchase of Exchange Traded Funds and Real Estate Investment Trusts A doubling in the pace of exchange-traded fund purchases. |
|
| European Central Bank | Pandemic Emergency Purchase Programme Purchases of private and public sector securities, until the end of 2020, up to a total amount of €750 billion. |
||
| US Federal Reserve | Primary Dealer Credit Facility Provide credit to primary dealers in exchange for a broad range of collateral for term funding with maturities up to 90 days. Commercial Paper Funding Facility Purchases from eligible issuers, via a Special Purpose Vehicle (SPV), of three-month US dollar-denominated commercial paper. Money Market Mutual Fund Facility Provision of liquidity to eligible money market mutual funds. |
Primary Market Corporate Credit Facility Purchase bonds from eligible issuers, via a SPV, and make loans to eligible borrowers. Secondary Market Corporate Credit Facility Purchases of investment grade corporate bonds in the secondary market from eligible issuers. |
Term Asset-Backed Securities Loan Facility Loans to holders of certain AAA-rated asset-backed securities based on newly and recently originated consumer and small business loans. |
Selected Central Bank Facilities to Support Funding Markets
| Money Markets and Government Securities | Corporate Bond Market | Other Markets | |
|---|---|---|---|
| Bank of Canada | Government of Canada Bond Purchase Program Purchases of Government of Canada bonds in the secondary market to support market functioning and provide monetary stimulus. Bankers’ Acceptance Purchase Facility Purchases of eligible bankers’ acceptances to maintain credit to small- and medium-sized businesses. Provincial Money Market Purchase Program Purchases of provincial money market securities in the primary market. Provincial Bond Purchase Program Purchases of provincial bonds in the secondary market to support the liquidity and efficiency of these markets. Commercial Paper Purchase Program Purchases of eligible commercial paper in the primary and secondary markets to maintain the smooth flow of credit to corporations. |
Corporate Bond Purchase Program Purchases of corporate bonds in the secondary market to support liquidity and market functioning. |
Canada Mortgage Bond Purchase Program Purchases of CMBs in the secondary market to support market functioning and the ability of financial institutions to finance mortgage lending to Canadian homeowners. |
| Bank of England | Asset Purchase Facility A £200 billion increase in the central bank’s holdings of UK government bonds and sterling nonfinancial investment-grade corporate bonds to a total of £645 billion. COVID Corporate Financing Facility For 12 months the central bank and Treasury will purchase commercial paper of maturities up to one year issued by companies making a material contribution to the UK economy. |
||
| Bank of Japan | Measures to Facilitate Corporate Financing Increased the upper limit of holdings of corporate bonds and commercial paper and introduced special funds-supplying operations to facilitate corporate financing. Active purchase of Japanese Government Bonds (JGBs) Conducted additional outright purchases of JGBs. Additional measures to maintain stability of the repo market Relaxed the conditions of its Securities Lending Facility (SLF). Conducted sales of Japanese Government Securities (JGS) with repurchase agreements intended to provide the market with JGS. |
Purchase of Exchange Traded Funds and Real Estate Investment Trusts A doubling in the pace of exchange-traded fund purchases. |
|
| European Central Bank | Pandemic Emergency Purchase Programme Purchases of private and public sector securities, until the end of 2020, up to a total amount of €750 billion. |
||
| US Federal Reserve | Primary Dealer Credit Facility Provide credit to primary dealers in exchange for a broad range of collateral for term funding with maturities up to 90 days. Commercial Paper Funding Facility Purchases from eligible issuers, via a Special Purpose Vehicle (SPV), of three-month US dollar-denominated commercial paper. Money Market Mutual Fund Facility Provision of liquidity to eligible money market mutual funds. |
Primary Market Corporate Credit Facility Purchase bonds from eligible issuers, via a SPV, and make loans to eligible borrowers. Secondary Market Corporate Credit Facility Purchases of investment grade corporate bonds in the secondary market from eligible issuers. |
Term Asset-Backed Securities Loan Facility Loans to holders of certain AAA-rated asset-backed securities based on newly and recently originated consumer and small business loans. |
Annex 2. MMF Reforms after the GFC
United States
The SEC adopted a first series of amendments to its rules on MMFs in 2010 that were designed to make these funds more resilient by reducing the interest rate, credit, and liquidity risks of their portfolios. Although the reforms improved MMF resilience, the SEC said at the time that it would continue to consider whether further, more fundamental changes to MMF regulation might be warranted. After further review, in July 2014 the SEC adopted more fundamental structural changes to the regulations of MMFs. These reforms required non-government institutional MMFs to “foat their NAV” (no longer maintain a stable price) and provided non-government MMF boards with new tools—liquidity fees and redemption gates—to address runs. Although these measures were adopted before the last US FSAP, they did not take effect until October 2016. MMFs that qualify as “government MMFs” and “retail MMFs” are still permitted to use the amortized cost method and/ or penny rounding method of pricing to seek to maintain a stable share price. A government MMF is defined as any MMF that invests 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements that are collateralized fully by government securities or cash and meet certain other regulatory requirements with respect to value and custody. A retail MMF is defined as a MMF that has policies and procedures reasonably designed to limit all beneficial owners of the MMF to natural persons. The broad reasoning behind this approach is that, for government MMFs, the safety of the eligible portfolio securities is such that a stable NAV is justified, while for retail MMFs the more patient holding strategy of the investors (who, according to historical holding patterns, are less likely to “run” during periods of stress) means that a stable NAV continues to be appropriate.
European Union (EU)
In the EU, the MMF Regulation (MMFR) took effect in July 2018. The new framework distinguished between three types of MMF: VNAV MMFs; public debt constant net asset value MMFs (public debt CNAV); and low volatility net asset value MMFs (LVNAV MMFs). VNAV can either be set up as short-term MMF or standard MMF which are subject to different portfolio rules, whereas public debt CNAV MMF and LVNAV MMF may only be set up as short-term MMF. The MMFR applies alongside the two cornerstones of EU investment fund regulation, the UCITS Directive and the Alternative Investment Fund Managers Directive.
Asia
Originally all MMFs in China were CNAV MMFs. A set of reforms that began in 2014 limited the types of asset in which MMFs can invest, strengthened requirements around liquidity risk management and sought to improve disclosures. The reforms also led eventually to the establishment of a pilot VNAV MMF in August 2019. In Japan, there were historically two categories of MMF vehicle: the Money Management Fund (JMMF) launched in 1992, and the Money Reserve Fund (MRF) launched in 1997. JMMFs and MRFs take the form of investment trusts which invest primarily in MMIs as well as government and corporate bonds with limited maturities according to the relevant legal provisions. In terms of AuM, JMMFs historically represented approximately one third of the combined MRF and JMMF TNA in 2010. JMMF have nevertheless progressively reduced in size and market share. Since May 2017, there are no longer any JMMFs in Japan. MRFs are used by broker-dealers in Japan for the purpose of settlement and pooling of cash, given the prohibition on broker-dealers accepting deposits. Given this specific purpose, MRFs are CNAV MMFs.
Annex 3. Detailed Presentation of MMF Policy Options
Detailed Presentation of MMF Policy Options
Detailed Presentation of MMF Policy Options
| Policy Option | Key Features | Pros | Cons |
|---|---|---|---|
| Decouple liquidity thresholds from fees and gates | This option allows funds to impose fees or gates when doing so is in the best interests of the fund. | Decreases incentives for redemptions and reduces the likelihood of gates | In absence of formal threshold, investors may apply their own threshold |
| Reform of conditions for imposing redemption fees/gates | Funds required to obtain permission from regulatory authorities prior to imposing fees/gates | Supervisor able to intervene to secure best interests of investors | May lead to undue delays in application of fees/gates Supervisors may not have sufficient data to allow informed decision on permitting/ denying imposition of fees/gates |
| Minimum balance at risk (MBR) | A portion of each shareholder’s recent balances in a MMF is available for redemption only with a time delay to ensure that redeeming investors remain partially invested in the fund over a certain time period | Decrease incentives for redemptions and potential for fire sales Reduces likelihood of suspensions Changes investor perception of MMF as cash-like MBR could be higher for institutional investors | Swing pricing and/or capital buffers may have similar beneficial effects with less complexity. |
| Liquidity buffer | New, stricter requirements on liquid assets imposed (higher thresholds and/or shorter durations for less liquid assets) | More stringent requirements on WLA would increase availability of liquidity during periods of market stress | More liquid assets is good per se from regulatory (c.f. commercial) perspective but may not suffice in period of extreme stress |
| Countercyclical liquidity buffer | Liquidity buffer rises or falls automatically in certain circumstances, such as when net redemptions are large | Addresses problems associated with minimum thresholds of WLA | Complex calibration required Depending on precise approach adopted, subject to reliability of stress tests |
| Floating NAVs for all nongovernment MMFs | Nongovernment MMFs required to move to become VNAV MMFs; NAVs move in line with market prices | Removes first-mover advantage Risks borne by investors clearer | Nongovernment MMFs would no longer be cash-equivalent |
| Swing pricing | MMF adjusts the dealing price for inflows or outflows to take into account the costs of purchasing or selling assets of the fund | Reduces redemption requests under stressed conditions Reduces first mover advantage Concrete evidence of positive effects on OEFs Legal basis already exists in major jurisdictions (EU/US) |
Choice between full and partial swing and calibration of swing can be complex Not possible for CNAV Successful implementation depends on availability of data on spread and cost information for MMIs (but introduction of swing pricing could encourage efforts to improve that data) |
| Macroprudential swing pricing | Regulators impose and calibrate swing pricing ex ante | Removes stigma effect for MMFs Takes account of systemic risk Less extreme than other LMTs, for example, suspensions | Calibration of tools requires significant data set on inflows/outflows and portfolio liquidity Could act as disincentive to investors in MMFs generally Full disclosure of trigger thresholds could strengthen run incentives |
| Capital buffer | Dedicated resources within or alongside fund to absorb losses | Allows losses to be absorbed without recourse to extraordinary CB intervention Reduces incentives for redemption by limiting risks of large losses to shareholders and first-mover advantage |
Not clear where resources for buffer would come from Application to VNAV MMFs would require calibration (for example only when NAV drops by large amount) |
| Centralized external support (liquidity exchange bank) | Centralized and pre-funded facility for MMFs to transact with during a crisis | Gives greater confidence to market that all MMF types able to withstand crisis scenario Could reduce first mover advantage | Would need to be applied across all major MMF jurisdictions to prevent arbitrage between covered and non-covered funds |
| Sponsor support | Prohibition of, or clarification of permissibility of, support from sponsor or related party | Outright prohibition would be neater solution Allows greater predictability in crisis scenario |
If sponsor support allowed, may unduly favor MMFs that belong to large banking groups |
| Adjust liquidity buffers according to the share of funds’ institutional investors | Liquidity buffers adjusted according to funds’ structural exposure to funding risk (institutional investors more likely to run) | Reduces first-mover advantage by recognizing greater propensity of institutional investors to run | Implementation more complex for funds with both retail and institutional investor base Data on liability side may be insufficient Burden on regulators to set increase/ decrease of buffer |
| Greater transparency on MMIs | Improved data on issuance and outstanding amount of MMIs in primary and secondary markets | May increase market liquidity and facilitate price discovery | No cons as such (greater transparency is always +ve) |
| Enhance MMF reporting framework | More harmonized, detailed and frequent reporting from MMFs to authorities | Gives authorities—both central banks and securities regulators—better overview of industry | No cons as such (greater transparency is always +ve) but market participants often argue that regulators do not use reporting data sufficiently to justify the extra costs involved |
| Abolish nongovernment MMFs | MMFs limited to government MMFs only | Clean, neat solution—reduces credit and liquidity risks significantly | Short-term bond funds not plausible alternative due to lack of cash-equivalence |
| Liquidity-based redemptions deferrals | MMF portfolio holdings are classified according to their liquidity; redemption is aligned with the fund’s liquidity profile | Reduces liquidity mismatch Less risk of fire sales Introduces clearer link between asset and liability side | May be some complexities in calibration |
| Limits on eligible assets for nongovernment MMFs | Stricter requirements on holdings of illiquid assets | Reduces liquidity mismatch | Issues around cash equivalence definition Defining liquid vs. ineligible assets may be challenging |
| MMF investor concentration limits | Limits on percentage of MMF shares held by a given investor | Reduces likelihood of suspension triggered by small number of investors | Application depends on quality of data on liabilities |
| Improved disclosure on STFM investor base | Holdings of main categories of investor made available per type of issuer, currency, and maturity | Aids regulators’ oversight of market | No cons per se; may be complex to implement |
| Stress testing by managers | More frequent and sophisticated stress tests undertaken according to parameters specified by authorities | Allows early identification of vulnerabilities Useful information for supervisors Strengthens IOSCO Recommendation 8 |
Discretion on parameters left to MMF managers |
| Stress testing by authorities | Systemwide stress testing of entire MMF sector | Same as for previous option but allows for regulators to prescribe more rigorous approach Gives genuine sector-wide picture | Dependent on access to/quality of data Follow-up of stress tests results depends on regulatory approach |
| Removal of stable NAV | All MMFs required to have floating NAV | Removes threshold effects Investors should become more aware of market risk | Removes important category of cash management vehicles |
| Prohibition on daily dealing for nongovernment MMFs | Only government MMFs allowed to offer daily redemptions | Addresses liquidity mismatch in prime MMFs Removes link between MMF withdrawals and margin calls (but risk potentially displaced elsewhere for example if MMF investors chose to rely instead on lines of credit for immediate cash needs). |
Reduced appetite for MMFs could lead to loss of funding source for MMI issuers |
| Redemptions in kind | Institutional investors receive share of portfolio securities instead of cash | Reduces first-mover advantage and incentives for large redemptions in times of stress | Cannot be used with retail investors Some funds currently do not allow redemption in kind proportionate to investor holdings in fund |
Detailed Presentation of MMF Policy Options
| Policy Option | Key Features | Pros | Cons |
|---|---|---|---|
| Decouple liquidity thresholds from fees and gates | This option allows funds to impose fees or gates when doing so is in the best interests of the fund. | Decreases incentives for redemptions and reduces the likelihood of gates | In absence of formal threshold, investors may apply their own threshold |
| Reform of conditions for imposing redemption fees/gates | Funds required to obtain permission from regulatory authorities prior to imposing fees/gates | Supervisor able to intervene to secure best interests of investors | May lead to undue delays in application of fees/gates Supervisors may not have sufficient data to allow informed decision on permitting/ denying imposition of fees/gates |
| Minimum balance at risk (MBR) | A portion of each shareholder’s recent balances in a MMF is available for redemption only with a time delay to ensure that redeeming investors remain partially invested in the fund over a certain time period | Decrease incentives for redemptions and potential for fire sales Reduces likelihood of suspensions Changes investor perception of MMF as cash-like MBR could be higher for institutional investors | Swing pricing and/or capital buffers may have similar beneficial effects with less complexity. |
| Liquidity buffer | New, stricter requirements on liquid assets imposed (higher thresholds and/or shorter durations for less liquid assets) | More stringent requirements on WLA would increase availability of liquidity during periods of market stress | More liquid assets is good per se from regulatory (c.f. commercial) perspective but may not suffice in period of extreme stress |
| Countercyclical liquidity buffer | Liquidity buffer rises or falls automatically in certain circumstances, such as when net redemptions are large | Addresses problems associated with minimum thresholds of WLA | Complex calibration required Depending on precise approach adopted, subject to reliability of stress tests |
| Floating NAVs for all nongovernment MMFs | Nongovernment MMFs required to move to become VNAV MMFs; NAVs move in line with market prices | Removes first-mover advantage Risks borne by investors clearer | Nongovernment MMFs would no longer be cash-equivalent |
| Swing pricing | MMF adjusts the dealing price for inflows or outflows to take into account the costs of purchasing or selling assets of the fund | Reduces redemption requests under stressed conditions Reduces first mover advantage Concrete evidence of positive effects on OEFs Legal basis already exists in major jurisdictions (EU/US) |
Choice between full and partial swing and calibration of swing can be complex Not possible for CNAV Successful implementation depends on availability of data on spread and cost information for MMIs (but introduction of swing pricing could encourage efforts to improve that data) |
| Macroprudential swing pricing | Regulators impose and calibrate swing pricing ex ante | Removes stigma effect for MMFs Takes account of systemic risk Less extreme than other LMTs, for example, suspensions | Calibration of tools requires significant data set on inflows/outflows and portfolio liquidity Could act as disincentive to investors in MMFs generally Full disclosure of trigger thresholds could strengthen run incentives |
| Capital buffer | Dedicated resources within or alongside fund to absorb losses | Allows losses to be absorbed without recourse to extraordinary CB intervention Reduces incentives for redemption by limiting risks of large losses to shareholders and first-mover advantage |
Not clear where resources for buffer would come from Application to VNAV MMFs would require calibration (for example only when NAV drops by large amount) |
| Centralized external support (liquidity exchange bank) | Centralized and pre-funded facility for MMFs to transact with during a crisis | Gives greater confidence to market that all MMF types able to withstand crisis scenario Could reduce first mover advantage | Would need to be applied across all major MMF jurisdictions to prevent arbitrage between covered and non-covered funds |
| Sponsor support | Prohibition of, or clarification of permissibility of, support from sponsor or related party | Outright prohibition would be neater solution Allows greater predictability in crisis scenario |
If sponsor support allowed, may unduly favor MMFs that belong to large banking groups |
| Adjust liquidity buffers according to the share of funds’ institutional investors | Liquidity buffers adjusted according to funds’ structural exposure to funding risk (institutional investors more likely to run) | Reduces first-mover advantage by recognizing greater propensity of institutional investors to run | Implementation more complex for funds with both retail and institutional investor base Data on liability side may be insufficient Burden on regulators to set increase/ decrease of buffer |
| Greater transparency on MMIs | Improved data on issuance and outstanding amount of MMIs in primary and secondary markets | May increase market liquidity and facilitate price discovery | No cons as such (greater transparency is always +ve) |
| Enhance MMF reporting framework | More harmonized, detailed and frequent reporting from MMFs to authorities | Gives authorities—both central banks and securities regulators—better overview of industry | No cons as such (greater transparency is always +ve) but market participants often argue that regulators do not use reporting data sufficiently to justify the extra costs involved |
| Abolish nongovernment MMFs | MMFs limited to government MMFs only | Clean, neat solution—reduces credit and liquidity risks significantly | Short-term bond funds not plausible alternative due to lack of cash-equivalence |
| Liquidity-based redemptions deferrals | MMF portfolio holdings are classified according to their liquidity; redemption is aligned with the fund’s liquidity profile | Reduces liquidity mismatch Less risk of fire sales Introduces clearer link between asset and liability side | May be some complexities in calibration |
| Limits on eligible assets for nongovernment MMFs | Stricter requirements on holdings of illiquid assets | Reduces liquidity mismatch | Issues around cash equivalence definition Defining liquid vs. ineligible assets may be challenging |
| MMF investor concentration limits | Limits on percentage of MMF shares held by a given investor | Reduces likelihood of suspension triggered by small number of investors | Application depends on quality of data on liabilities |
| Improved disclosure on STFM investor base | Holdings of main categories of investor made available per type of issuer, currency, and maturity | Aids regulators’ oversight of market | No cons per se; may be complex to implement |
| Stress testing by managers | More frequent and sophisticated stress tests undertaken according to parameters specified by authorities | Allows early identification of vulnerabilities Useful information for supervisors Strengthens IOSCO Recommendation 8 |
Discretion on parameters left to MMF managers |
| Stress testing by authorities | Systemwide stress testing of entire MMF sector | Same as for previous option but allows for regulators to prescribe more rigorous approach Gives genuine sector-wide picture | Dependent on access to/quality of data Follow-up of stress tests results depends on regulatory approach |
| Removal of stable NAV | All MMFs required to have floating NAV | Removes threshold effects Investors should become more aware of market risk | Removes important category of cash management vehicles |
| Prohibition on daily dealing for nongovernment MMFs | Only government MMFs allowed to offer daily redemptions | Addresses liquidity mismatch in prime MMFs Removes link between MMF withdrawals and margin calls (but risk potentially displaced elsewhere for example if MMF investors chose to rely instead on lines of credit for immediate cash needs). |
Reduced appetite for MMFs could lead to loss of funding source for MMI issuers |
| Redemptions in kind | Institutional investors receive share of portfolio securities instead of cash | Reduces first-mover advantage and incentives for large redemptions in times of stress | Cannot be used with retail investors Some funds currently do not allow redemption in kind proportionate to investor holdings in fund |
Annex 4. Recent Developments on International Standards for OEFs
International standards on financial stability issues relating to OEFs have been further developed in recent years. There has been significant work by the FSB and IOSCO devoted to developing policy on relevant OEF areas that has translated into enhanced standards on a number of areas.
The FSB issued policy recommendations to address structural vulnerabilities from asset management activities in 2017, focused on four areas: (i) liquidity mismatch between investments and redemption terms and conditions; (ii) leverage within funds; (iii) operational risk and challenges at asset managers in stressed conditions; and (iv) securities lending activities of asset managers and funds.
IOSCO issued two important documents in 2018 and 2019 covering LRM and leverage.
Recommendations for LRM for Collective Investment Schemes (2018), build on the 2012 Principles, elaborating on issues like suitability of dealing frequency of funds’ units to better align assets and liabilities; disclosure of funds’ liquidity profiles; operability of liquidity management tools; and fund level stress testing. The document also includes new recommendations on contingency planning.
Recommendations for a framework to assessing leverage in investment funds (2019) develop a two-step framework to facilitate more meaningful monitoring, using measures of leverage to first identify and analyze funds that may pose financial stability risks, followed by further analysis of such funds. IOSCO is expected to collect leverage data from its membership to implement step 1.
IOSCO’s work on OEFs goes beyond what is summarized here.
While IOSCO’s work on LRM and leverage offers significant guidance, its recommendations may not prove fully effective in addressing potential financial stability issues. Due to the complexity and diversity of the sector and numerous important differences in national legal frameworks, the recommendations necessarily remain high-level, leaving a number of key issues open to discretion. Moreover, a number of recommendations are applicable only to the extent that regulatory frameworks permit which also weakens their effectiveness.
Providing supplementary guidance to supervisors on specific areas relevant to financial stability would greatly improve international standards. While obtaining consensus on every regulatory and supervisory item around OEFs is overly complex and unnecessary, reaching agreement on the key areas that impact for how OEFs behave in relation to systemic risk will prove very beneficial. Some of these, where we believe more concrete guidance is necessary are fagged in Chapter 4 of this paper, including aligning liquidity and frequency of redemptions at the design phase, widening the availability of LRM tools and broader use of swing pricing.
References
Adrian, T., N. Boyarchenko, and O. Shachar. 2017. “Dealer Balance Sheets and Bond Liquidity Provision.” Journal of Monetary Economics 89 (C): 92–109.
Adrian, T., P. Colla, and H. Shin. 2012. “Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007–9.” Working Paper 18335. National Bureau of Economic Research, Cambridge, MA.
Anadu, K., M. Kruttli, P. McCabe, and E. Osambela. 2020. “The Shift from Active to Passive Investing: Risks to Financial Stability?” Working Paper SRA 18–04, Federal Reserve Bank of Boston, Boston.
Ambrose, B., N. Cai, and J. Helwege. 2008. “Forced Selling of Fallen Angels.” Journal of Fixed Income 18: 72–85.
Arslanalp, S., D. Drakopoulos, R. Goel, and R. Koepke. 2020. “Benchmark-Driven Investments in Emerging Market Bond Markets: Taking Stock.” Working Paper 20/192, International Monetary Fund, Washington, DC.
Bao, J., M. O’Hara, and X. Zhou. 2018. “The Volcker Rule and Corporate Bond Market Making in Times of Stress.” Journal of Financial Economics 130 (1): 95–113.
Brandão-Marques, L., G. Gelos, and N. Melgar. 2018. “Country Transparency and the Global Transmission of Financial Shocks.” Journal of Banking and Finance 96 (1): 56–72.
Broner, F., G. Gelos, and C. Reinhart. 2006. “When in Peril, Retrench: Testing the Portfolio Channel of Contagion.” Journal of International Economics 69 (1): 203–30.
Cai, F., S. Han, D. Li, and Y. Li. 2016. “Institutional Herding and its Price Impact: Evidence from the Corporate Bond Market.” Finance and Economics Discussion Series 2016–091, Board of Governors of the Federal Reserve System, Washington, DC.
Capponi, A., P. Glasserman, and M. Weber. Forthcoming. “Swing Pricing for Mutual Funds: Breaking the Feedback Loop Between Fire Sales and Fund Runs.” Management Science.
Chen, Sally, D. Drakopoulos, and R. Goel. 2019, “China Deepens Global Finance Links as It Joins Benchmark Indexes.” IMFBlog, June 19.
Chernenko, S., and A. Sunderam. 2019. “Do Fire-Sales Create Externalities?” Journal of Financial Economics 135 (3): 602–28.
Chernenko, S., and A. Sunderam. 2020. “Measuring the Perceived Liquidity of the Corporate Bond Market.” NBER Working Paper Series, No. 27092, National Bureau of Economic Research, Cambridge, MA.
Choi, J., and M. Kronlund. 2018. “Reaching for Yield in Corporate Bond Mutual Funds.” Review of Financial Studies 31 (5): 1930–65.
Cortes, F., and L. Sanflippo. 2020. “Do Multi-Sector Bond Funds Pose Risks to Emerging Markets?” Working Paper 20/152, International Monetary Fund. Washington, DC:
Coval, J., and E. Staford. 2007. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics 86 (2): 479–512.
Cremers, M., and A. Petajisto. 2009. “How Active is Your Fund Manager? A New Measure that Predicts Performance.” Review of Financial Studies 22 (9): 3329–65.
Diamond, D., and P. Dybvig. 1983. “Bank Runs, Deposit Insurance and Liquidity.” Journal of Political Economy 91 (3): 401–19.
Ellul, A., C. Jotikasthira, and C. Lundblad. 2011. “Regulatory Pressure and Fire-Sales in the Corporate Bond Market.” Journal of Financial Economics 101: 596–620.
Ellul, A., C. Jotikasthira, A. Kartasheva, C. Lundblad, and W. Wagner. 2018. “Insurers as Asset Managers and Systemic Risk.” Working Paper 12849, Centre for Economic Policy Research. London.
Eom, Y., J. Helwege, and J-Z. Huang. 2004. “Structural Models of Corporate Bond Pricing: An Empirical Analysis.” Review of Financial Studies 17: 499–544.
European Securities Markets Association (ESMA). 2020. Performance and Costs of EU Retail Investment Products 2021. Paris.
Financial Stability Board. (FSB) 2020a. Holistic Review of the March Market Turmoil. Basel.
Financial Stability Board (FSB). 2020b. Global Monitoring Report on Non-Bank Financial Intermediation. Basel.
Financial Stability Board. (FSB) 2021. Policy Proposals to Enhance Money Market Fund Resilience: Consultation Report. Basel.
Gale, D. 1995. “Dynamic Coordination Games.” Economic Theory 5 (1): 1–18.
Gelos, G., and S. Wei. 2003. “Transparency and International Investor Behavior.” EFA 2003 Annual Conference Paper No. 325, Chattanooga, TN, February 10
Gerlach, P., and R. Maurer. 2020. “The Growing Importance of Secondary Market Activities for Open-End Real Estate Fund Shares in Germany.” Schmalenbach Business Review 72 (1): 65–106.
Goldstein, I., and C. Huang. 2016. “Bayesian Persuasion in Coordination Games.” American Economic Review: Papers and Proceedings 106 (5): 592–6.
Hespeler, F., and F. Suntheim. 2020. “The Behavior of Fixed Income Funds during the COVID-19 Market Turmoil.” Global Financial Stability Notes, International Monetary Fund, Washington, DC.
Huang, J-Z., Z. Sun, T. Yao, and T. Yu. 2020. “Liquidity Premium in the Eye of the Beholder: An Analysis of the Clientele Effect in the Corporate Bond Market.” Management Science 66 (2): 932–57.
International Monetary Fund (IMF). 2014. “Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While Promoting Growth.” Global Financial Stability Report. Washington, DC, April.
International Monetary Fund (IMF). 2015. “The Asset Management Industry and Financial Stability.” Chapter 3 of The Global Financial Stability Report, Washington, DC, October.
International Monetary Fund (IMF). 2016a. “The Insurance Sector—Trends and Systemic Risk Implications.” Chapter 3 of The Global Financial Stability Report, Washington, DC, April.
International Monetary Fund. 2016b. Ireland Financial Sector Stability Assessment Technical Note – Asset Management and Financial Stability. Country Report 16/132, Washington, DC.
International Monetary Fund. 2016c. United Kingdom Financial Sector Stability Assessment. Country Report 16/167, Washington, DC.
International Monetary Fund. 2017a. Luxembourg Financial Sector Stability Assessment Technical Note – Risk Analysis. Country Report 17/261, Washington, DC.
International Monetary Fund. 2017c. “Growth-at-Risk and Financial Stability.” Chapter 3 of The Global Financial Stability Report, Washington, DC, October.
International Monetary Fund. 2018a. Brazil Financial Sector Stability Assessment Technical Note – Stress Testing and Systemic Risk Analysis. Country Report 18/344, Washington, DC.
International Monetary Fund. 2018b. “A Decade after the Global Financial Crisis: Are We Safer?.” Chapter 2 of The Global Financial Stability Report, Washington, DC, October.
International Monetary Fund. 2019. The Global Financial Stability Report, Washington, DC, April and October.
International Monetary Fund. 2020a. The Global Financial Stability Report, Washington, DC, April and October.
International Monetary Fund. 2020b. Canada Financial Sector Stability Assessment Technical Note – Stress Testing and Financial Stability Analysis. Country Report 20/16, Washington, D.C.
International Monetary Fund. 2020c. United States Financial Sector Stability Assessment Technical Note – Risk Analysis and Stress Testing the Financial Sector. Country Report 20/247, Washington, D.C.
International Monetary Fund. 2020d. A Conceptual Model for the Integrated Policy Framework. Working Paper 20/121, Washington, D.C.
International Monetary Fund. 2020e. A Quantitative Model for the Integrated Policy Framework. Working Paper 20/122, Washington, D.C.
International Monetary Fund. 2021a. “Preempting a Legacy of Vulnerabilities.” Chapter 1 of The Global Financial Stability Report, Washington, DC, April.
International Organization of Securities Commissions (IOSCO). 2012. Final Report on Recommendations for Money Market Funds. November.
International Organization of Securities Commissions (IOSCO). 2018. Open-ended Fund Liquidity and Risk Management—Good Practices and Issues for Consideration. February.
International Organization of Securities Commissions (IOSC). 2020. Money Market Funds during the March-April Episode. November.
Jeanne, O., and R. Rancière. 2008. “The Optimal Level of International Reserves For Emerging Market Countries: A New Formula and Some Applications.” Discussion Paper 6723, Centre for Economic Policy Research, London.
Jin, D., M. Kacperczyk, J. Kahraman, and F. Suntheim. 2019. “Swing Pricing and Fragility in Open-End Mutual Funds.” Working Paper 19/227, International Monetary Fund, Washington, DC.
Kamenica, E., and M. Gentzkow. 2011. “Bayesian Persuasion.” American Economic Review 101 (6): 2590–615.
Kose, A., E. Prasad, and M. Terrones. 2009. “Does Financial Globalization Promote Risk Sharing?” Journal of Development Economics 89 (2): 258–70.
Li, L., Y. Li, M. Machiavelli, and X. Zhou. 2020. “Liquidity Restrictions, Runs and Central Bank Interventions: Evidence from Money Market Funds.” Review of Financial Studies
Miguel, A., and D. Su. 2019. “Explaining Differences in the Flow-Performance Sensitivity of Retail and Institutional Mutual Funds— International Evidence.” Teoretical Economics Letters 9 (7): 2711–31.
Miyajima, K., and I. Shim. 2014. “Asset Managers in Emerging Markets Economies.” BIS Quarterly Review (September) 19–34.
Raddatz. C., S. Schmukler, and T. Williams. 2017. “International Asset Allocations and Capital Flows: The Benchmark Effect.” Journal of International Economics 108 (C): 413–30.
Surti, J. 2004. “Rational Speculation, Financial Crises and Optimal Policy.” IMF Working Paper 04/25, International Monetary Fund, Washington, DC.
Sushko, V., and G. Turner. 2018. “The Implications of Passive Investing for Securities Markets.” BIS Quarterly (March) 113–31.
US Department of the Treasury. 2020. Report of the President’s WorkingGroup on Financial Markets: Overview of Recent Events and Potential Reform Options for Money Market Funds. Washington, DC.
Zeng, Y. 2018. “A Dynamic Theory of Mutual Funds and Liquidity Management.” Working Paper, University of Washington, Seattle.
There are some exceptions, such as certain mutual funds that offer monthly or quarterly liquidity. However, such funds represent a small fraction of total assets under management. We are generally excluding private funds including private equity, hedge funds, and family offices from this paper, which tend to feature lock ups.
Market-based finance can be understood as liquidity, maturity and credit transformation services provided by non-bank financial intermediaries to institutional and retail investors. Relative to banks’ provision of these services, market-based financial intermediaries do not necessarily support their business with large balance-sheets and equity; hence, they can pass on a significantly larger (range of) financial risks to end-investors.
For the purpose of this paper, when we refer to investment funds, we include money market funds, open ended funds such as mutual funds, closed end funds, and exchange traded funds. We exclude hedge funds, private equity funds, family offices, pension funds, and insurance funds.
Financial Stability Board (2020b).
IMF (2020b) and Hespeler and Suntheim (2020). This paper does not assess the implications for other parts of the NBFI universe implicated by the March 2020 market turmoil and other recent events in advanced economies and EMDEs, including elevated interconnectedness of NBFIs and banks and data gaps related to the same; procyclicality of CCP margins; and the impact of rising life expectancy and persistently low interest rates for pension funds and life insurers.
Post-GFC reform applicable to investment funds differed across countries. For example, while the United States removed stable net-asset-valuation (CNAV) practice for non-government MMFs offered to institutional investors outright by 2016, corresponding reform in the European Union was not based on an equally stark boundary depending on investors and assets.
In the aftermath of the March 2020 events, the FSB is looking at the issues around NBFI, as part of its holistic review program of the March 2020 events (FSB 2020a) and has set up a Steering Committee on NBFIs.
The trade-of between protecting the financial system against collapse by providing official backstops in emergency situations and engendering moral hazard reflected in an increase in risk appetite of the private sector in normal times is fundamental. The logic of the waterfall of policy interventions with central bank emergency liquidity assistance placed at the end is to attenuate this trade-of in two ways. First, policy tools placed higher in the waterfall serve to tighten prudential rules governing the operation of investment funds. Second, placing central bank backstop at the bottom of the waterfall reserves its use for situations where its option value is highest, namely, in the tail of the shock distribution.
It is important to note that market-based financial intermediation, particularly debt markets, provide an important countercyclical buffer against shocks by providing firms and financial institutions with a spare tire to secure the (re)financing necessary to maintain operations. Evidence from the United States demonstrates that issuance in primary debt markets can partially fill funding gaps opened by crisis-induced declines in the supply of bank loans, in particular for bigger, higher rated and less leveraged issuers and/or those which have more tangible assets and broader opportunities for additional investments (Adrian, Colla and Shin 2012).
Principle 6 (The Regulator should have or contribute to a process to identify, monitor, mitigate and manage systemic risk, appropriate to its mandate) was added in the 2010 update of IOSCO Objectives and Principles.
Examples include recommendations of the US FSAP 2015 for the entire securities sector and the Technical Notes on securities regulatory and supervisory issues in recent FSAPs, including Ireland 2016, U.K. 2016, Germany 2016, Luxembourg 2017, The Netherlands 2017, New Zealand 2017, Sweden 2017, Brazil 2018, and the US 2020.
Annex 2 details MMF policy reform undertaken in the European Union, Asian countries, and the United States after the GFC.
CNAV MMFs seek to maintain an unchanging face value NAV (for example $1/€1 per unit/share) with assets generally valued on an amortized cost basis. From an investor perspective, this makes CNAV MMF shares isomorphic to demand deposits from a safety of capital preservation perspective (in normal times). Absent deposit insurance-like protection, however, it opens up CNAV MMFs to strategic complementarity driven redemption runs (Diamond and Dybvig 1983).
Specifically, if the weekly liquid asset (WLA) buffer share falls to below 30 percent of total net assets of the MMF, where WLA includes cash, US Treasury securities, certain other government securities with remaining maturities of 60 days or fewer, and securities that convert into cash within one week. See: https://www.sec.gov/news/press-release/2014-143. European rules also define a specific threshold at which a fund’s board of directors may consider applying a fee or gate (30 percent weekly liquidity), followed by another threshold at which the fund must apply a fee or gate (10 percent weekly liquidity). The United States also has an additional 10 percent WLA tier rule.
IOSCO (2012). Participating jurisdictions included Brazil, China, France, India, Ireland, Japan, Luxembourg, the United Kingdom and the United States, together representing 95 percent of the total net assets managed by MMFs worldwide.
Robustness checks showed the insignificance of other potential redemption drivers in last year’s events, including the degree of investor sophistication, availability of (bank) sponsor support, and factors that were important in 2008, such as MMF performance and the degree of their exposure to less liquid assets (long-term debt).
The US impact will be less significant since only retail prime MMFs have CNAV structures now.
Other variations have been discussed, for example, adjusting the buffer to the share of institutional investors in the fund. These may have merit also, but their complexity could impose costs on both the industry and supervisors. Hence, it is preferable to proceed by strengthening existing buffers before assessing the merits of other mechanisms.
Chernenko and Sunderam (2019) show in the context of equity mutual funds that provision of incentives to fund managers to internalize fire-sale externalities increases their holdings of cash buffers and their use in meeting redemption spikes. Raising prime MMF WLA buffers and making them countercyclical would serve the same purpose.
Access to central bank facilities to government MMFs is less susceptible to moral hazard and faces less ambiguity concerning its net welfare implications.
Annex 3 contains a detailed summary of several proposals. See also US Department of the Treasury (2020) and FSB (2021).
For example, US Generally Accepted Accounting Principles includes MMFs as an example of a cash equivalent exposure and the US Securities and Exchange Commission has clarified that this treatment extends to MMFs that have the ability to gate or penalize redemptions under normal market conditions. In the EU, IAS 7 defines cash equivalents as “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.” The French Accounting Standards Authority and the Autorité des Marchés Financiers (Financial Markets Regulator) clarified that funds authorized under the MMF regulation would benefit from a presumption of eligibility for classification as cash equivalents, albeit acknowledge that this “presumption of risk negligible variation in the value of these funds can be refuted in view of the facts and circumstances relating to market developments, especially in times of stress.”
Building on IOSCO’s Recommendation 8—MMFs should periodically conduct appropriate stress testing.
See Recommendations of the most recent FSAPs of the United States (2020) and Ireland (2016). Eventually, given the extensive cross-border nature of the business, global top-down stress tests utilizing harmonized data reporting would be a useful add-on to national stress tests.
In the first half of 2020, mutual funds suspended withdrawals from funds with a total of $62 billion in assets under management, 0.11 percent of the sector’s total assets. Of the funds that suspended redemptions, real estate funds were the most prevalent.
Bao and others (2018) attribute this to the implementation of the Volcker Rule rather than other elements of Basel III.
Operational factors have been cited as a material factor impeding use by US OEFs. (https://www.sec.gov/rules/final/2016/33-10234.pdf) while regulatory proscription may be a factor in countries like Germany.
Conceptually, designing swing pricing optimally is a problem of Bayesian (persuasion) mechanism design, to neutralize value destroying strategic complementarities. See Kamenica and Gentzkow (2014) and Goldstein and Huang (2016).
To avoid setting swing factors too low, funds could be asked to take market-wide redemption and liquidity conditions into account when calibrating the size of the swing factor. And supervisory action may be required to ensure coordinated and universal adaptation by the industry of this practice.
See, for example, IMF (2016b, 2016c, 2017, 2018, 2020b, 2020c). Currently, Recommendation 17 in the IOSCO Recommendations for LRM states that “responsible entities should consider the implementation of additional liquidity management tools to the extent allowed by local law and reglation.”
OEFs dedicated to insurance products (for example, variable annuities) may be more flexible in terms of redemption, including redemption-in-kind, as insurers are less likely to face significant redemption pressure.
See Annex 4.
This could possibly be done in combination with fostering secondary markets for fund shares to allow investors access to liquidity even if redemptions are restricted. For example, while secondary market trading activity in German open-end real estate fund shares seems to have been very limited in the past, it has been increasing following the introduction of minimum holding periods and mandatory notice periods in 2011 (Gerlach and Maurer 2020).
The United States has recently amended rules on use of derivatives by investment funds and improved reporting via Form N-PORT (including monthly portfolio composition), which should provide an enhancement in data collection and oversight. For the European Undertakings for the Collective Investments in Transferable Securities (UCITS) market, detailed reporting requirements are in place only on a selected basis in some countries and there is no EU-wide reporting framework. The European Securities Markets Association’s guidance on UCITS use of leverage requires funds to choose between specific methodologies and to disclose—via prospectus and annual reports—the expected level of leverage. The IMF’s Financial Soundness Indicators Guide (2019) represents a step in this direction, presenting a uniform measurement methodology for key financial indicators for MMFs.
These trends vary across countries, with foreign non-bank investors accounting for almost 50 percent of the total investors in some countries, such as Peru and Uruguay, while they are relatively marginal in China and India (Figure 8, panel 5).
At the other end of the spectrum are unconstrained multi-sector bond funds who freely choose portfolio allocations unshackled of benchmark indices. The end-investors in benchmark-driven funds and unconstrained funds such as open-end multi-sector bond funds can be retail or institutional.
Almost 30 percent of EM funds benchmarked invest in local sovereign debt, 45 percent invest in EM of-shore sovereign debt and about 15 percent in EM offshore corporate debt.
The active share of a fund is defined as the sum of the absolute value of deviations of the fund’s country weights from those of the benchmark (Cremers and Petajisto 2009).
This finding is corroborated using other metrics, such as the average tracking error—the difference between the return of a fund and its benchmark—of EM local bond funds.
Miyajima and Shim (2014) show that asset managers investing in EMs tend to behave in a correlated manner. Some of this behavior is because of common or similar portfolio benchmarks and the directional co-movement of end-investor flows.
Latest data highlights that median frontier financial market depth is at 0.08 which compares with 0.33 for emerging financial market depth and 0.63 for advanced financial market depth (Figure 8, panel 4). While domestic financial deepening helps reduce yield volatility, greater foreign participation in local currency bond markets increases it beyond certain thresholds (IMF 2020).
In terms of the relative importance, Egypt, Nigeria and Ghana have the highest weights at 2.6, 1.5, and 1.5 percent of EMBIG Global Diversified respectively (Figure 11, panel 2).
Assigning index components in a direct proportion to the market cap can also induce financial stability issues and doesn’t address all these concerns. It may induce market discipline distortions raising issuer incentives to increase leverage and also expose the benchmark driven investors to more vulnerable and highly indebted issuers.
The spillovers work in the other direction as well as highlighted in the study by Raddatz and others (2017). In June 2013, Qatar and the United Arab Emirates were upgraded from the MSCI Frontier Markets Index to the MSCI EM Index. Since these countries accounted for about 40 percent of the MSCI FM Index, the funds tracking benchmarked had to significantly increase their loading in the other frontier countries sharing the index, resulting in significant inflows and stock market price increases in countries such as Kuwait, Nigeria, and Pakistan.
Of total assets under management of $1 trillion, the 40 largest MSBFs’ EM investments ranged from $100–$160 billion in recent years. The bulk of their EM investments are in sovereign bonds and bonds of state-owned enterprises. As of Q2: 2020, these EM investments amounted to $85 billion and $15 billion, respectively.
During the last decade, these 40 MSBFs accounted at times for greater than 20 percent of the foreign investor base of sovereign bond markets in Hungary, Malaysia, Ukraine, and Uruguay. More recently, they exceeded 10 percent of the foreign investor base in Brazil, India, and Mexico. MSBFs reached historical lows in their investment concentration in many EMs following the COVID-19 crisis (as of Q2: 2020) as they rebalanced their portfolios into safer assets and sold positions in response to redemptions.
A good example is Indonesia’s corporate prudential foreign exchange regulation which requires a minimum rating and hedging of short-term external debt to help moderate risks from corporate external debt.
Transparent and efficient accounting standards and legal frameworks have been shown to help reduce the adverse effects from global financial shocks (Brandão-Marques and others 2018; Gelos and Wei 2003).
A premature or partial inclusion of debt instruments in international bond indices can introduce bond-market fragmentation or concentration risks, respectively.
Ireland, Luxembourg, the United Kingdom, and the United States are examples of countries wherein EME funds are domiciled and that have already made available policy tools to manage internal fund liquidity (IOSCO 2018).
UCITS-eligible funds are subject to a 10 percent limit on the amount that a portfolio can hold of a single issue; and, for the aggregate investment in which the UCITS fund invests, no more than 5 percent of the assets can exceed 40 percent of the value of the portfolio. In addition to the concentration limits under the EU UCITS Directive IV, UCITS must explicitly address liquidity risk in the portfolio, although the guidelines lack specificity. In the United States, the 1940 Investment Company Act states that, for 75 percent of the portfolio of a diversified fund, investment in a single issuer is limited to 5 percent of the value of the fund’s total assets and 10 percent of the outstanding voting securities of the issuer (and therefore contrary to UCITS, there is no portfolio aggregation limit); for the remaining 25 percent of the fund’s assets, there is no concentration limit and they can be invested in a single issuer.